In a marathon meeting lasting nearly 20 hours, Congress’ conference committee finalized the new financial regulation bill at 5:39am ET on Friday. Next, the merged bill goes back to both chambers for their individual votes. The rushed process was completed on-time early Friday morning so that President Obama could explain the new rules Congress will impose to the G-20 this weekend in Toronto. Assuming the votes go smoothly, the bill should pass in both chambers by July 4th. Here are some of the major highlights from the night and morning’s proceedings:

Volcker Rule

A watered-down ban of proprietary trading, also known as the Volcker Rule, passed. The final version of the rule would allow banks to participate in private equity and hedge funds up to 3% of their tier 1 capital. They could only, however, have up to 3% ownership of any private equity or hedge fund.

A conflict-of-interest provision was included in this amendment, which was inspired by the Goldman-SEC case. No market-maker can engage in any transaction that could result in a conflict-of-interest with any real or synthetic asset-backed security it has acted as underwriter, placement agent, initial purchaser, or sponsor for in the past year.

House Republicans were worried about the U.S. unilaterally imposing the Volcker Rule without similar measures taken by other nations. The fear was that U.S. competitiveness could be harmed if other nations don’t adopt similar regulation. They consequently offered an amendment that would have prevented the Volcker Rule from being effective until at least a majority of the G-20 had agreed to adopt a similar rule. The amendment failed.

Sen. Kanjorski (D-PA) also was bothered by the use of tier 1 capital instead of tangible common equity (TCE). The initial version of the rule would have used TCE instead of tier 1 capital. He said that tier 1 allowed too much flexibility for banks, as he indicated that it provided approximately 40% more investment in private equity and hedge funds. His amendment was rejected.

Derivatives

The big question here was Senator Lincoln’s (D-AR) so-called spin-of provision. It would require banks to put their swaps desks in a separately capitalized subsidiary. The Senate’s offer included a major change. Certain types of derivatives could be retained, while others would need to be put in subsidiaries, as follows:

The big disappointment is that capital requirements, which I think to be the most important part of the bill, didn’t end up in the final legislation. Instead, that’s left to regulators, although it’s hard to imagine that anything in the bill will stop regulators from getting caught up in bubble-mania. Still, this is an ambitious, thoughtful piece of legislation that addresses some of the system’s worst failings (like the unregulated derivatives market) and adds a raft of protections. The work of financial regulation is trying to draw out the time between the last crisis and the next one, and this bill does seem likely to do that.

Since the central goal of the bill was to manage risk one might ask, ‘where does the risk go?’ Public policy analysts will have to spend hours is figuring out who ultimately holds what in the 2,000 page bill. Financial risk cannot be legislated away. Like energy, once in existence risk cannot be destroyed. It can only be moved around; assumed by someone. When it assumed for a fee the risk transfer is called insurance. When it is assumed by the taxpayer the result is something like Freddie Mac and Fannie Mae. Yet public or private the it remains in the system for so long as the transactions which gave rise to it are allowed. It is the distribution of risks that is affected by the bill. In that sense the spin-offs on derivatives trading mandated by Blanche Lincoln do not reduce total risk within the system. They simply prohibit banks from assuming it, assuming they do not simply reallow under other color through loopholes. Shara Tibken at the Wall Street Journal reports that that banks are expected to adapt happily now that the obligatory theatrics are over.

“It’s a great moment. I’m proud to have been here. No one will know until this is actually in place how it works. But we believe we’ve done something that has been needed for a long time. It took a crisis to bring us to the point where we could actually get this job done.”

That’s a “teary” Sen. Chris Dodd (D-Conn.), on the financial overhaul bill assembled by leaders in both houses this week. So Dodd, the chair of the committee with jurisdiction over the bill, has no idea how the bill work. Which also means he has no idea if it will work. Which also means he has no idea if the bill will do more harm than good. Nonetheless, he’s certain it was needed, and is proud to have helped make it happen.

A final, macro thought on where we go from here: Many hands have been wrung (including my own at times) about the fact that financial bureaucrats will have so much influence over the shape of the legislation. Even if you trust Team Obama (as I do), you have to worry about their possible successors under a GOP administration bent on waging anti-regulatory jihad. In fact, you don’t even need to imagine that to be anxious. History shows that even otherwise sober-minded officials are just as susceptible to bubble psychology as the rest of us.

But if there are ways that financial regulation is likely to weaken over time, there are other ways that it’s likely to strengthen. For example, the Democratic leadership was finally forced to exempt auto dealers from the new consumer regulatory agency late last night—Barney Frank, the lead House negotiator, conceded that they just didn’t have the votes to do otherwise. But that hardly strikes me as the final word on regulating auto loans. To the contrary, now that we’ve taken the big step of creating a consumer agency, it strikes me as relatively easy to expand its purview. And I’m guessing that the next time we hear about a sympathetic military family getting screwed by a deceptive auto loan, that’s what’s going to happen. So this bill really is just the beginning in more ways than one.

Prediction: if you thought financial instruments were complex before, wait until you get a load of the vehicles Wall Street will construct to get around these rules.

In addition, banks will have two years to spin-off their derivatives trading, and can retain the operations under independently capitalized affiliates. This latter might do some good if it keeps the riskiest products off the balance sheets of the biggest banks — effectively creating a good bank / bad bank situation in advance, instead of trying to do it on a sinking ship, as Lehman tried in September of 2008.

The timing is especially helpful for President Obama, who leaves today for Canada for a G20 meeting, and who wanted to be able to tell global leaders that the United States is poised to complete its work on financial regulatory reform. Now, he’ll be able to do just that, and Obama spoke briefly to the press this morning to herald the legislative breakthrough, most notably the new consumer protection agency, and calling the larger package the “toughest” industry regulations in generations.

The NYT‘s report is worth reading in full, to get a sense of the changes that were made through the negotiations, most notably to the Volcker Rule. Note that while intense industry lobbying influenced the process, and produced “some specific exceptions to new regulations,” by and large “the bill’s financial regulations not only remained strong but in some cases gained strength.”

The House and Senate are expected to bring the conference committee bill to the floor next week. Senate Republicans will very likely launch a filibuster — they have no shame — but leaders are confident the legislation will pass.

And in the larger context, this will add to an impressive list of historic accomplishments spanning President Obama’s first 18 months in office, a list that will now include Wall Street reform, health care reform, student loan reform, economic recovery, Lilly Ledbetter Fair Pay Act, expanded civil rights protections, expanded stem-cell research, new regulation of the credit card industry, new regulation of the tobacco industry, a national service bill, and the most sweeping land-protection act in 15 years, among other things.

Taegan Goddard noted this morning, “Not since FDR has a president done so much to transform the country.” That’s not a hyperbolic observation in the slightest.